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According to The New York Times, even after taxpayers rescued Citigroup, regulators at the New York Federal Reserve failed to monitor the company adequately. The regulators, although adequately staffed and proficient in training, failed to move swiftly as the bank’s financial condition deteriorated from as early as 2005, and were overly optimistic about the bank’s prospects as late as December, 2009. From 2006 to 2007, decisions on poorly underwritten loans were changed from “turned down” to “approved.” As many as 80 percent of the loans that Citigroup sold to Fannie Mae, Ginnie Mae and other investors were defective. “Although the dedicated supervisory team is well-qualified and generally has sound knowledge of the organization, there have been significant weaknesses in the execution of the supervisory program,” according to one excerpt of the 2009 review. Tim Geithner, who as president of the New York Fed from 2003 to 2008 was in charge of overseeing Citigroup, went on to become the US Secretary of the Treasury.

In questioning a panel testifying before the Financial Crisis Inquiry Commission on April 7, 2010, Brooksley E. Born, the former regulator in the Clinton administration who had lost the battle over derivatives regulation to Alan Greenspan, Robert Rubin, and Larry Summers, called on Greenspan in his testimony to defend his longtime deregulatory bent. “The Fed utterly failed to prevent the financial crisis,” she said. She went on to claim, “The Fed and the banking regulators failed to prevent the housing bubble. They failed to prevent the predatory lending scandal. They failed to prevent our biggest banks and bank holding companies from engaging in activities that would bring them to the verge of collapse without massive taxpayer bailouts… . Didn’t the Federal Reserve fail to meet its mandates, fail to meet it responsibilities?” Greenspan replied that there was a failure: an underestimation of the “state and extent” of financial risks and the ability of private counterparties to assess them, but he added that, “(t)he notion that somehow my views on regulation were predominant and effective at influencing the Congress is something you may have perceived,” he said. “But it didn’t look that way from my point of view.” However, according to other accounts, the trioka of Summers, Rubin and Greenspan had gone after Born for wanted to regulate the derivatives (see, for example, Sorkin’s Too Big To Fail). The three did indeed lobby Congress in an effort to sabatage Born’s proposal. Besides reporting this, Sorkin also points out that Citigroup’s CEO and its major stockholder were instrumental in getting Geithner appointed as President of the New York Fed. A coincidence with the overly optimistic view of the Fed’s regulators regarding Citi?

In questioning Robert Rubin on April 8th, Born (and other commissioners) asked why derivatives were kept unregulated. Rubin replied that the bankers were strongly opposed to such regulation, and they were able to effect their stand in Congress. Rubin did not go into the efforts of him, Summers and Greenspan to lobby Congress to keep the instruments unregulated; instead, he claimed that he favored regulating the derivatives even when he was at Goldman Sachs supervising the bank’s trading desk, and that when at Treasury he was merely concerned that regulating the instruments under the existing regulatory structure could cause delaying legal challenges. While Rubin’s frankness concerning the influence of the bankers in the US Government is useful, his testimony regarding himself seems less than forthcoming. Presumably he could have lobbied Congress as the Treasury Secretary for a new regulatory authority to regulate the derivatives on a solid legal basis. Instead, he lobbied against Born’s efforts to get the instruments regulated. He admitted that the financial sector would have been strongly opposed to such a regulatory authority. Also, he had been on the board of Citigroup and an executive at Goldman Sachs. The conflict of interest is too strong in his case for his asseverations that he had always acted in favor of regulating the instruments to be believable. His “worry of legal challenges” strikes me as a technical excuse that he was using as a subterfuge to “explain” his opposition to Born’s efforts to regulate the derivatives. Doubtless he could count on the American public and its media for not digging sufficiently to expose his duplicity. That is to say, it is likely that Rubin got away with protecting his ex-bank’s interests when he was Secretary of the Treasury and was strategically able to come off as having advocated the public interest all along. Hence, in general, the culpits were able to maintain their credibility and position themselves to be the officials we turn to to fix the problem.

The influence of the bankers in the halls of government (and its central bank) is perhaps the cause of the Fed’s deficiencies in regulating Citigroup (and in the Clinton Administration’s position against regulating the sub-prime mortgage derivative securities). In the case of the New York Fed, the board that appoints the NY Fed President consists of Wall Street bankers. There is a structural conflict of interest in having the regulated appoint the regulator. This structural conflict of interest manifested itself materially in the case of Tim Geithner and Citigroup. This is a textbook example of a conflict of interest, and yet it went under the radar screen. The focus in regulatory deficiency is typically instead on whether the regulators are sufficiently staffed and trained, and perhaps on whether they are relying too much on information from the regulatees. The more basic structural conflicts of interest are rarely made transparent, yet we will continue to see regulatory “deficiencies” manifest from them unless structural or institutional reforms are made. I am continually amazed at how such glaring institutional conflicts of interest are ignored by the public and the media. I would expect the politicians and the business practioners to try to keep it hush hush, but the inability of the American people to grasp the problem confounds my attempt to explain it.

Sources: http://www.nytimes.com/2010/04/08/business/08panel.html?ref=us ; CSPAN.

In the fall of 2008, European politicians were pointing to the bad finance in America as putting the entire world at risk financially.  In May, 2010,  however, the E.U. had its own financial crisis and bailout. The added problem in arriving at a coordinated response given the relative power held by the state governments meant that the debt crisis in the E.U. could have been the contagion more likely to spread.  Whereas in the U.S., the U.S. Government’s treasury secretary and the Federal Reserve Chairman orchastrated the bailout at a dizzying pace, the more balanced federalism of the E.U. meant that the leaders of the state governments were the active players. In other words, even though the E.U. evinces a more balanced division of power between the union and state governments than is is the case in the decentralized-consolidated modern incarnation of American "federalism," the ability of the Europeans to tackle the problem of several of its states hemmoraging in public debt attests to the messiness that is inherent in a well-balanced federal system.  Even so, the consolidated condition of American government meant that states in trouble such as Florida, Illinois and California had to fend for themselves because neither the U.S. Government nor the Federal Reserve was under pressure to come to their aid. The Federal Reserve, for example, had printing hundreds of billions of dollars to assuage the U.S. Government's growing appetite for debt. However, when U.S. Senators asked Chairman Bernanke about doing likewise for the trouble state governments, he replied that the Fed was not autorized to do it. This asymmetry itself pushes the system even closer to the consolidated end of the political spectrum. As some of the U.S. Constitutional Convention delegates warned in 1787 even when the U.S. consisted of just thirteen republics, it is difficult for a central government to have sufficient energy throughout an empire-scale "extended republic."  The E.U. following its first fifty years was better able to cover the inherent diversity there, yet not yet sufficient to support its unified aims (such as a common currency backed up by coordinated fiscal policy).

In short, the financial problems that occasioned the huge financial bailouts is hardly an American quagmire.  Just as the E.U. and U.S. have different divisions of power in their applications of modern federalism, the processes and solutions themselves must undoubtedly differ as well. In the end, hard choices irrespective of the federal systems involved will need to be made at the expense of instant gratification in order for a sustainable (i.e., real) fiscal trajectory in the West to be realized.  The struggle is perhaps against expediency in a time of apparent plenty.

Testifying before the US Senate Finance Committee on his re-appointment, Ben Bernanke volunteered that the Fed had been “slow” in protecting consumers from high-risk mortgages during the housing bubble and that it should have forced banks to hold more capital for all the risks they were taking on.  “In the area where we had responsibility, the bank holding companies, we should have done more.” he told lawmakers.  The hearing provided new evidence of doubt among lawmakers about the Federal Reserve’s  role as the nation’s guardian of the financial system. “In the face of rising home prices and risky mortgage underwriting, the Fed failed to act,” said Senator Richard Shelby of Alabama, the senior Republican on the banking committee. “Many of the Fed’s responses, in my view, greatly amplified the problem of moral hazard stemming from ‘too big to fail’ treatment of large financial institutions and activities.”  Accordingly, Senator Dodd proposed that the Fed’s powers as a bank regulator ought to be transferred to a new consolidated agency. Even though Bernanke admitted that the Fed made mistakes as a regulator of the bank holding companies, he and other top Fed officials adamantly opposed Dodd's proposal, arguing that the Fed has unique expertise nonetheless and that the Fed's ability to preserve financial stability depends on having the detailed information that only a regulator has about the inner workings of major institutions.

The Fed has “unique expertise," and yet, “In the area where we had responsibility, the bank holding companies, we should have done more.”   In other words, the Fed’s Chairman admitted that his agency had not done a satisfactory job of regulating banks during the housing bubble and yet his organization should be given even more power as a regulator anyway.  Were we to trust the Fed to regulate systemic risk, given the agency’s squalid record leading up to the financial crisis of 2008? Regardless of what qualms this question may have raised, the Dodd-Frank legislation charged the Fed with guarding the financial stability of the United States. It gave the central bank the power to oversee the largest financial institutions, even if they are not banks. Finally, it gave the Fed a prominent role on the Financial Stability Oversight Council, a body of regulators that will have the power to seize a systemically important company if it threatens the stability of the economy. Testifying before the Financial Crisis Inquiry Commission on September 2, 2010, Bernanke signaled that the central bank was eager to embrace its strengthened role provided for in the Dodd-Frank law. This role ought to give us pause, given his remarks in 2007 in which he thought the subprime problems were “manageable.” To the Commission in 2010, he said, “What I did not recognize was the extent to which the system had flaws and weaknesses in it that were going to amplify the initial shock from subprime and make it into a much bigger crisis.”

Sources: http://www.nytimes.com/2009/12/04/business/economy/04fed.html?ref=business ; http://www.nytimes.com/2010/09/03/business/03commission.html?_r=1&ref=business

Just as the US Senate was to take up the matter of Ben Bernanke’s re-appointment as Chair of the Federal Reserve in 2010, Time magazine came out with its announcement that he is to be its person of the year.  According to the magazine, “when turbulence in U.S. housing markets metastasized into the worst global financial crisis in more than 75 years, he conjured up trillions of new dollars and blasted them into the economy; engineered massive public rescues of failing private companies; ratcheted down interest rates to zero; lent to mutual funds, hedge funds, foreign banks, investment banks, manufacturers, insurers and other borrowers who had never dreamed of receiving Fed cash; jump-started stalled credit markets in everything from car loans to corporate paper; revolutionized housing finance with a breathtaking shopping spree for mortgage bonds; blew up the Fed’s balance sheet to three times its previous size; and generally transformed the staid arena of central banking into a stage for desperate improvisation. He didn’t just reshape U.S. monetary policy; he led an effort to save the world economy.”  Not to be outdone in service to the Chairman, CNN furnished its own reporters, who gave credit to Bernanke for these measures.  Interestingly, however, even though one reporter admitted that Bernanke had said in 2007 that the subprime market and its derivatives would not threaten the financial market and the banks, she attributed the fault there to the imperfections in the market rather than to Bernanke himself in being wrong.   So, he gets credit for cleaning up the mess (ignoring the foreclosed homeowners) but not the blame for being wrong about the contagion (and not urging regulation of the derivatives).  He could have urged the regulation of derivatives (he is a smart person), and once the crisis occurred, he could have tailored his response to the homeowners facing foreclosures that could have been stopped. For example, the Fed could have created dollars to subsidize the inordinate rates on the variable rate subprime mortgages (i.e. those bank assets would not have been toxic and the banks’ balance sheets would have been fine…two birds with one stone…rather than doing the bidding of one of the parties).  To be sure, if the Fed is inordinately friendly to banks because of the power they have in selecting their regulators (the NY Fed Chair’s appointing committee consists of bankers), then Bernanke might have simply been playing the good politics for staying in office.   “Our ships must all sail in the same direction; otherwise who can tell how long you will…last…with us.” (The Godfather, part III)  Bernanke is a player from the perspective of the real power behind the throne: America’s financial elite.  That elite literally owns the media companies. So what I want to point out here is that the timing of Time’s announcement and the asymetry in CNN’s laudatory coverage of the Chairman just as the Senate was about to consider his re-appointment led me almost instinctually to  be convinced that coincidence was not the driver here.  The Chairman undoubtedly had some powerful friends in the media who were giving him a publicity offensive, or campaign, just in time for the Senate debate on whether to appoint him.

Through all the admiration of this person of 2009, it should be remembered that he did not urge the regulation of sub-prime derivatives issued or held by the banks regulated by the Fed.  He was wrong about the subprime housing bubble being contained.  And he failed to protect homeowners sufficiently.  If the media was being used by the Fed Chair in his re-appointment campaign, it could be that what we are fed by CNN, Fox, MSNBC and the main network newscasts is not really as neutral or beyond their control as we think.   News as a campaign.  News because it is in some powerful actor’s vested interests.  While there is certainly coincidence in life, an alignment such as I have outlined here is far too transparent—or at least it ought to be.

The subtext here is that we, the American people, have become too much the pawns even as we think we are not.  The illusion of popular sovereignty is that we are in control.   I don’t think we have any idea of the extent to which we are manipulated by the powers that transcend our elected representatives and their appointees.  It is no wonder that real change does not get beyond the interests of the real power in America, whose interest is in the status quo or at best in an incremental change.   Essentially, we have allowed the anti-democratic power to concentrate to a degree that is dangerous to a functioning republic (i.e., a representative democracy).  We should not be surprised to find that powerful actors are operating at a subterranean level where transparency is intentionally lacking.    How do we get it back, you ask?  Hah!   We would have to see it first—realize its extent and depth—and I’m not holding my breath that enough people will wake up to see the light.

Too many of us are ensconced in Plato’s cave, taking what the puppets say for reality.  As Jack Nicholson said in A Few Good Men, “You want answers? YOU CAN’T HANDLE THE TRUTH!”    Even if we could stomach the emetic manipulation behind the scenes that is directed to us (and even our representatives—when they aren’t doing it themselves), we would have to be able to see it—and it is so well hidden.  We can only grasp at straws…confluences that seem like more than coincidences.  As a member of the black caucus of the US House (surprisingly) said to a reporter of Frontline on the TARP program passing the House just days after it had been voted down by that same body, “You have no idea how powerful the anti-democratic forces are here.”    You and I get only glimpses.  The puppets seem more real so we believe in them.   Please don’t take my thesis to be that there is one huge orchastrated conspiracy; rather, I’m simply suggesting that our system of representative democracy does not seem to be able to sufficiently constrain the invisible powers that are pulling strings without being accountable to the public power.  It is my ardent hope that the people will look beyond the status quo in voting for candidates—perhaps getting back to citizen representatives who do their duty then return to their preferred occupations—that we would elect people sufficiently principled and not desirous of a life in power to be willing to take on the financial power.   Do I think it will happen?  Sadly, no.  I’m sorry, but I just don’t think we have it in us…or we don’t have enough of what it would take to confront that which is in us that favors comfort and sleep.   In the story of the rise and fall of empires, the United States is not exempt.  The culprit, as with most things, lies within.   It is ultimately about what kind of people too many of us are.  Such a thing is very, very difficult to change, let alone see.  Decadence tends to be invisible to itself.

Note: A day after CNN covered the announcement, the Senate finance committee debated and voted on Bernanke’s re-appointment. See http://www.msnbc.msn.com/id/34463144/ns/business-stocks_and_economy/

 Source: http://www.time.com/time/specials/packages/article/0,28804,1946375_1947251,00.html#ixzz0Zs8WgpV1

Testifying before the Financial Crisis Inquiry Commission on September 2, 2010, Ben Bernanke, chairman of the Federal Reserve, observed, “As of 2003 and 2004, there really was quite a bit of disagreement among economists about whether there was a bubble, how big it was, whether it was a local or a national bubble. We certainly were aware it was a risk factor, but frankly by the time it was clear it was a bubble” it was too late to address it through monetary policy. The NYT also reported that he spoke favorably of forcing huge banks to hold much more capital, particularly if they were systemically important — so much capital, indeed, that being big would be costly. He advocated that the increased capital requirements should include capital that is more aligned with risk and able to absorb losses more effectively, and that works in a countercyclical manner, so that banks have more of it during times of stress. Given the difficulty involved in recognizing a bubble even as it crests, Bernanke’s statements on capital-holding changes make sense. Absent breaking up banks too big to fail, making it very costly for them to be big is the next best option. The regulators would be wise to be on the look out, however, for bankers who try to hide their banks’ true sizes (and risk). Given the empire-building proclivity in the business world, designing a system that makes bigness more costly could result in an overall balance of forces. The key is to make being big sufficiently costly so that the drive to empire-build is sufficiently checked.

Source: http://www.nytimes.com/2010/09/03/business/03commission.html?_r=1&ref=business

Washington’s seeming willingness to print money rather than tackle tough debt-cutting measures is in sharp contrast to the approaches to relieving the public debts in Europe.  Ireland, for example, plans to nearly double its package of spending cuts and tax increases to try rein in its huge deficit.  Even so, borrowing costs in Spain, Portugal and Greece spiked upward again in late 2010 as investor concern re-emerged that those EU states would be hard-pressed to bring their deficits under control and avoid defaulting on their bonds. In short, the public deficits on both sides of the Atlantic are intractable problems—they being so deep.  Perhaps the only thing that can be said is that relying solely on tax increases or spending cuts is insufficient, and that beginning or continuing tax cuts is foolhardy.  It has been shown that Reagan’s tax cuts did not make produce more revenue for the US Government than it lost from the cuts themselves.  Some combination of tax increases and spending cuts seems inevitable in the West.  The trouble is, the problem is not just economic. “The scale of the deficits are just so big,” said Philip R. Lane, a professor of international economics at Trinity College in Dublin. “The issues are political as much as they are economic.”

See: http://www.nytimes.com/2010/11/08/business/global/08debt.html?_r=1&hp

The New York Times reports, “At their first meeting of the year, Federal Reserve policy makers voted unanimously … to continue the central bank’s controversial $600 billion plan to spur the recovery by buying government bonds.” In other words, the central bank would continue to “print money” to buy up U.S. Government debt, allowing that government to go into more debt without putting pressure on the interest rate to go up (which would cost the government more in interest payments to bondholders). Theoretically, the Federal Reserve can buy an unlimited amount of bonds because the central bank can create money. Of course, creating money relative to GNP growth can spark inflation, but the central bankers are not worries. “The Fed did note that commodity prices had risen, but cautioned that long-term inflation expectations had been stable and that measures of underlying inflation had continued to trend downward.” Even so, “skeptics fear that the bond-buying — which has the effect of further expanding the Fed’s already large balance sheet — could lead to destabilizing asset bubbles or touch off inflation.” I contend that this is a rather narrow (though certainly valid) concern; equally or more troubling for the long term is the asymetry in the Fed’s treatment of debt issued by the U.S. Government and that of the state governments. For instance, in 2010 Illinois issued $16 billion in additional debt. Whereas the U.S.Government could fall back on the Federal Reserve, the latter has refused to purchase debt from states like Illinois. Aside from the unfairness inherent in the Federal Reserve’s proclivity, the asymetry subtly undercuts federalism. In other words, the U.S. Government having an unlimited ability to have its central bank purchase its debt gives that government still another edge over the state governments, which one can expect will be even more compromised in being able to check encroachments by the U.S. Government. The resulting enervation of federalism means that consolidation may reach us sooner rather than later, at the expense of our governments being able to act as mutual checks on eachother. Another way of making this point is to charge that the Federal Reserve’s refusal to do for the state governments what the central bank is doing for the U.S. Government evinces a structural bias in our system of federalism. The lack of balance (and the underlying unfairness) ought to be of concern to the citizenry. The result may well be that the U.S. Government will be enabled to get into unsustainable debt such that the empire itself may one day collapse under its own weight at the center.

Source: http://www.nytimes.com/2011/01/27/business/economy/27fed.html?ref=business

In January, 2011, the Financial Crisis Commission announced its findings. The usual suspects are not much of a surprise; what is particularly notable is how little had changed on Wall Street since the crisis in September of 2008. According to the New York Times, "The report examined the risky mortgage loans that helped build the housing bubble; the packaging of those loans into exotic securities that were sold to investors; and the heedless placement of giant bets on those investments." In spite of the Financial Reform Act of 2010 and the panel's report, the New York Times reports that "little on Wall Street has changed." One commissioner, Byron S. Georgiou, a Nevada lawyer, said the financial system was “not really very different” today from before the crisis. “In fact, the concentration of financial assets in the largest commercial and investment banks is really significantly higher today than it was in the run-up to the crisis, as a result of the evisceration of some of the institutions, and the consolidation and merger of others into larger institutions,” he said. Richard Baker, the president of the Managed Funds Association, told the <i>Financial Times</i>, "The most recent financial crisis was caused by institutions that didn't know how to adequately manage risk and were over-leveraged. And I worry that if there is another crisis, it will be because the same institutions have failed to learn from the mistakes of the past." From the testimonies of managers of some of those institutions, one might surmise that the lack of learning has been due to a refusal to admit to even a partial role in the 2008 crisis.  In other words, there appears to be a crisis of mentality, which is not easily fixed.

To comprehend the danger in the continuance of the status quo, it is helpful to digest the panel's findings. The crisis commission found "a bias toward deregulation by government officials, and mismanagement by financiers who failed to perceive the risks." This ought to raise a red flag when we hear politicians urge more deregulation.  "Don't they get it?" one might reasonably conclude. Lest it be thought that the panel proffered a pro-government verdict, however, the commission also concluded that "Fannie and Freddie had loosened underwriting standards, bought and guaranteed riskier loans and increased their purchases of mortgage-backed securities because they were fearful of losing more market share to Wall Street competitors." These two organizations were not really market participants, however, as they were guaranteed by the U.S. Government. That government-backed corporations would act so much like private competitive firms undercuts the assumed civic mission that premises government-underwriting. In other words, the government-backed entities were neither civic as from government nor effective as private companies. In other words, government-established "firms" can behave like the private companies they were intended to check, yet this does not mean that more de-regulation is the solution.

In terms of the private sector, The New York Times reports that the panel "offered new evidence that officials at Citigroup and Merrill Lynch had portrayed mortgage-related investments to investors as being safer than they really were. It noted — Goldman’s denials to the contrary — that 'Goldman has been criticized — and sued — for selling its subprime mortgage securities to clients while simultaneously betting against those securities.'”  The bank's proprietary net short position can not be justified by simply market-making as a counter-party to its clients, Blankfein's congressional testimony notwithstanding. Relatedly, the panel also pointed to problems in executive compensation at the banks. For example, Stanley O’Neal, chief executive of Merrill Lynch, a bank which failed in the crisis, told the commission about a “dawning awareness” through September 2007 that mortgage securities had been causing disastrous losses at the firm; in spite of his incompetence, he walked away weeks later with a severance package worth $161.5 million. The panel might have gone on to point to the historically relatively huge difference between CEO and lower-level manager compensation and questioned the relative merit, but such a conclusion would go beyond the commission's mission to explain the financial crisis.

In terms of the government, The New York Times reports that the panel "showed that the Fed and the Treasury Department had been plunged into uncertainty and hesitation after Bear Stearns was sold to JPMorgan Chase in March 2008, which contributed to a series of “inconsistent” bailout-related decisions later that year." The Federal Reserve was clearly the steward of lending standards in this country,” said one commissioner, John W. Thompson, a technology executive. “They chose not to act.” Furthermore, Sabeth Siddique, a top Fed regulator, described how his 2005 warnings about the surge in “irresponsible loans” had prompted an “ideological turf war” within the Fed — and resistance from bankers who had accused him of “denying the American dream” to potential home borrowers. That is to say, the Federal Reserve, a corporation wholly owned by the U.S. Government, is too beholden to bankers instead of the common good. So we are back to the issue of a government-guaranteed corporation acting like or on behalf of private companies (and badly at that).

Sources: http://www.nytimes.com/2011/01/28/business/economy/28inquiry.html?_r=1&ref=business
Sam Jones, "Hedge Funds Rebuke Goldman," <i>Financial Times</i>, January 28, 2011, p. 18.

On greed as a culprit potentially restrained normatively (i.e, by religious ethics, for example), see: http://wordenreport.tumblr.com/post/2734313770/godliness-greed-how-effective-is-christian-ethics-in